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The Entrepreneuriill Process

WWho can be an entrepreneur you ask?

Anyone who wants to experience the deep, dark canyons of uncertainty and ambiguity .. and who wants to walk the breathtaking highlands of success. But I caution, do not plan to walk the latter, until you have experienced the former. "

ResullS ExpeCled

An Entrepreneur

Upon completion of this chapter you wiU have:

1. Developed a definition of entrepreneurship and the entrepreneurial process that spans life-style to high potential ventures.

2. Examined the practical issues you will address and explore throughout the book.

3. Learned how entrepreneurs and their financial backers get the odds for success in their favor, defying the pattern of disappointment and failure experienced by many.

4. Examined The Timmons Model of the entrepreneurial process, how it can be applied to your entrepreneurial career aspirations and ideas for businesses, and how recent research confirms it validity.

5. Analyzed the proposed startup of PC Build, Inc. by two about-to-graduate students.

Oem yslifying Enlrepreneurship

Entrepreneurship is a way of thinking, reasoning, and acting that is opportunity obsessed, holistic in approach, and leadership balanced. 1 Entrepreneurship results in the creation, enhancement, realization, and renewal of value, not just for owners, but for all participants and stakeholders. At the heart of this process is the creation and/or recognition of op· portunities." followed by the will and initiative to seize these opportunities. It requires a willingness to take risks-both personal and financial-but in a very calculated fashion in order to constantly shift

the odds to your favor, balancing the risk with the potential reward. Typically, entrepreneurs devise ingenious strategies to marshall their limited resources.

Today, entrepreneurship has evolved beyond the classic startup notion to include companies and organizations of all types, in all stages. Thus, entrepreneurship can occur-andfail to occur-in new firms and in old; in small firms and large; in fast and slow growingfinns; in the private, not-for-profit, and public sectors; in all geographic points; and all stages of a nation's development, regardless of politics.

1 This definition of entrepreneurship has evolved over the past two decades from research at Babson College and the Harvard Business School; and has recently been enhanced by Stephen Spinelli. Jr., John H. Muller, Jr .. Tenn Chair at Babson College.

teamwork, and vision. They face dilemmas and must make decisions despite ambiguity and contradictions. Very rarely is entrepreneurship a get-rich-quick proposition; rather, it is o!le of building-eand continually renewing-lang-term value and durable cashflow. The result of this value creation process, as we saw in Chapter 1, is that the total economic pie grows larger and society benefits.

Classic Entrepreneurship: The Startup

The classic expression of entrepreneurship is the raw startup company, an innovative idea that catapults as a high growth company. The best of these become entrepreneuriallegends: Netscape, Amazon.Corn, Sun Microsystems, Home Depot, McDonald's, Compaq Computer, Intuit, Staples, and hundreds of others have become household names. In addition to the entrepreneurial leadership qualities noted above, success usually involves building a team with complementary skills and talents, the ability to work as a team, and sensing an opportunity where others see contradiction, chaos, and confusion. It also requires the skill and ingenuity to find and control resourcesoften owned by others-to pursue the opportunity. And it means making sure the upstart venture does not run out of monev when it needs it the most.

_.

Entrepreneurship in Post-Brontosaurus Capitalism:

Beyond Startups

As we saw in Chapter 1, the upstart companies of the 1970s and 1980s have had a profound impact on the competitive structure of American and world industries. Giant firms, such as IBM (knocked off by Apple Computer and then Microsoft), Digital Equipment Corporation (another victim of Apple Computer and recently acquired by Compaq Computer Corporation), Sears (demolished by upstart Wal-Mart) and AT&T (knocked from its perch first by Mel, and then by cellular upstarts: McCaw Communications, Inc., Cellular One, and others), once thought invincible, have been dismembered by the new wave of entrepreneurial ventures. The resulting downsizing during the 1980s was still going strong by the end of 1997, as the top 10 job cuts alone amounted to 65,700 jobs, led by Kodak (10,000), Woolworth (9,200), Citicorp (9,000) and International Paper (9,000).3

As autopsy after autopsy was performed, a fascinating pattern emerged, showing, at worst, total disregard for the winning entrepreneurial approaches of their new rivals, and at best, a glacial pace in recognizing the impending demise and changing course.

"People Don't Want to Be Managed. They Want to Be Led!"4

These giant firms can be characterized, during their highly vulnerable periods, as hierarchical in structure with many layers of review, approvals, vetos, and decision making. Their tired executive blood conceived of leadership by managing and administering from the top down, a quite custodial set of assumptions about what the E-Generation was in search of for meaningful careers. This is in stark contrast to Ewing M. Kauffman's powerful insight: "People don't want to be managed; they want to be led!" These stagnating giants tended to reward people who accumulated the largest assets, budgets, number of plants, products, and head count, rather than rewarding those who created or found new business opportunities, took calculated risks and occasionally made mistakes, and did so with bootstrap resources. While very cognizant of the importance of corporate culture and strategy, their pace was glacial: The research on dozens of giant companies in the 1970s-80s concludes that typically it took six years for a large firm to change its strategy and 10 to 30 years to change its culture.

To make matters worse, they had many bureaucratic tendencies, particularly arrogance. They shared a blind belief that if they followed the almost sacred best-management practices of the day they could not help but prevail. It is noteworthy that during the 1970s-80s, these best-management practices did not include entrepreneurship, entrepreneurial leadership, and entrepreneurial reasoning. If anything, these were considered dirty words in corporate America. Chief among these sacred cows was: Stay close to your customer. What may shock you is the recent conclusion of two Harvard Business School professors:

One of the most consistent patterns in business is the failure of leading companies to stay at the top of their industries when technologies or markets change ... But a more fundamental reason lies at the heart of the paradox: leading companies succumb to one of the most popular, valuable management-dogmas. They stay close to their customers.f

Reminiscent of the case in Chapter 1, where upstart Cellular One in Boston dramatically outper-

formed giant NYNEX, the authors explain how this heretical outcome can happen.

When they do attack, the [new] entrant companies find the established players to be easy and unprepared opponents because the opponents have been looking upmarkets themselves, discounting the threat from below"

One gets further insight into just how vulnerable

and fragile the larger, so-called well managed companies can become, and why it is the newcomers who pose the greatest threat. This pattern also explains why there are tremendous opportunities for the coming E-Generation even in markets that are currently dominated by large players. Professors Bower and Christensen summarize it this way:

The problem is that managers keep doing what has worked in the past: serving the rapidly growing needs of their current customers. The processes that successful, well-managed companies have developed to allocate resources among proposed investments are incapable of funneling resources in programs that current customers explicitly don't want and whose profit margins seem unattractive. 7

Coupled with what we saw in Chapter 1 regarding how many new innovations, firms, and industries have been created in the past 30 years, it is no wonder that Brontosaurus Capitalism has found its Ice Age.

Signs of Hope in a Corporate Ice Age

Fortunately, for many giant firms, the entrepreneurial revolution may spare them from their own Ice Age. One of the most exciting developments of the decade is the response by some large, established U.S. corporations to the revolution in entrepreneurial leadership. After nearly three decades of experiencing the demise of giant after giant, corporate leadership, in unprecedented numbers, are launching experiments and strategies to recapture their entrepreneurial spirit and to instill the culture and practices we would characterize as entrepreneurial reasoning. The EGeneration has too many attractive opportunities to work in truly entrepreneurial environments to have to work for a brontosaurus.

Increasingly, we see examples of large companies who are adopting principles of entrepreneurship and entrepreneurial leadership in order to survive and to renew. A new magazine, Fast Company, is setting the new standard in entrepreneurial journalism. Stories document how large firms are applying what we

~ Ibid. p. 47. , Ibid.

" Fast Compam], June-Julv 1987. PI' :12.78. and ]04.

29

would call entrepreneurial thinking in pioneering ways to invent their futures, including companies like Harley-Davidson Motorcycles ($1.35 billion revenue), Marshall Industries ($2.2 billion), and Science Applications International Corporation (SAIC) in San Diego.8 Most large brontosaurus firms could learn valuable lessons on how to apply entrepreneurial thinking from companies such as these.

Metaphors

Improvisation. Quick, agile thinking. Resourcefulness. Inventiveness. Whatever the adjective to describe the behavior, innumerable metaphors from other parts of life can describe the complex world of the entrepreneur and the entrepreneurial process. From music it is jazz, with its uniquely American impromptu flair. From sports many metaphors exist: the Michael Jordan dominance and flair, the broken-field running of Terrell Davis or Barry Sanders, the wizardry on ice of Wayne Gretzky, freestyle snowboarding, a downhill run on skis, or the creativity and competitiveness of Tiger Woods.

Perhaps the game of golf, more than any other, replicates the complex and dynamic nature of managing risk and reward and all the intricate mental challenges that are faced in entrepreneuring. No other sport at one time demands so much physically, is so complex, intricate, and delicate, and is simultaneously so rewarding and punishing; and none tests one's will, patience, self-discipline, and self-control like golf. This is what entrepreneurs face as well. And if you think that the team concept isn't important in golf, remember that the 1997 American Ryder Cup team, which failed to work together as a team, lost to the Europeans.

An entrepreneur also faces challenges like a symphony conductor or a coach who must blend and balance a group of diverse people with different skills, talents, and personalities into a superb team. On many occasions it demands all the talents and agility of a juggler who must, under great stress, keep many balls in the air at once, making sure if one comes down it belongs to someone else.

The complex decisions and numerous alternatives facing the entrepreneur also have many parallels with the game of chess. As in chess, the victory goes to the most creative player, who can imagine several alternative moves in advance, and anticipate the possible defenses. This kind of mental agility is frequently demanded in entrepreneurial decision making.

30

Part I The Opportunity

Still another parallel can be drawn from the book The Right Stuff, later made into a movie. The first pilot to break the sound barrier, Chuck Yeager, describes what it was like to be at the edge of both the atmosphere and his plane's performance capability, a zone never before entered-just like the first-time en trepreneur,

In the thin air at the edge of space, where the stars and the moon came out at noon, in an atmosphere so thin that the ordinary laws of aerodynamics no longer applied and a plane could skid into a flat spin like a cereal bowl on a waxed Formica counter and then start tumbling, end over end like a brick, , , you had to he "afraid to panic." In the skids, the tumbles, the spins, there was only one thing y~u could let yourself think about: what do I do next?'

This feeling is frequently the reality on earth for entrepreneurs who run out of cashl

Regardless of the metaphor or analogy you choose for entrepreneurship, each is likely to describe a creative, even artistic, improvised act. The outcomes are often either highly rewarding successes or painful and visible misses, Always, urgency is on the doorstep,

Enlrepreneursnip = ParaDOXeS

One of the most confounding aspects of the entrepreneurial process is its contradictions. Because of its highly dynamic, fluid, ambiguous, and chaotic character, its constant changes frequently pose paradoxes. What follows is a sampling. Can you think up some that you have observed or heard about?

An opportunity with no or uen; low potential can he an cnormouslq big opportunity, One of the most famous examples of this paradox is Apple Computer Corporation, Founders Steve Jobs and Steve Wozniak approached their employer. Hewlett-Packard Corporation, with the idea for a desktop, personal computer and were told this was not an opportunity for HP, so they started their own company. Frequently, business plans rejected by some venture capitalists become legendary successes when backed bv another investor. Intuit, maker of Quicken 'software, for example, was rejected by 20 venture capitalists before securing backing. In order to make money you have to first lose money. It is commonly said in the venture ?apital business that the lemons, or losers, ripen m two-an~-a-half years, while the plums take seven or eIght years to ripen. A startup, venture-

""111: \\'r,if." f/ /I' J t ~'I Cf ,. k

.,' I~ I . '"~ . _,,'W Yor , Bantam Boob, ]9S0), pp. 51~52

backed company typically loses money, often $10-25 million and more, prior to sustaining profitability and going public, usually at least five to seven years later,

In order to create and build wealth one must relinqUish wealth. Among America's most successful growing companies, the founders aggreSSively dilute their own ownership in order to create ownership throughout the company. By rewarding and sharing the wealth with the people who contribute Significantly to its creation, owners motivate others to make the pie bigger.

In order to succeed one first has to experience failure, It is a common pattern that the first venture fails, yet the entrepreneur learns and goes on to create a highly successful company, Jerry Kaplan teamed with Lotus Development Corporation founder Mitch Kapor to start the first pen-based computer. After $80 million of venture capital investment the company was shut down, Kaplan went on to launch On-Sale, Inc., and Internet Dutch-auction, which exploded in growth and went public in 1996.

Entrepreneurship requires considerable thought, preparation and planning, yet is basically an unplannable event. The highly dvnamio, changing character of technology, markets, and competition make it impossible to know all your competitors today, let alone five years hence, Yet great effort is invested in attempting to model and envision that future, The resulting business plan is inevitably obsolete when it comes off the printer. It is important to remember that this is a creative process-like molding clay. You need to make a habit of planning and reacting as you constantly reevaluate your options, blending the messages from your head and your gut, until this process becomes second nature.

In order for creativity and innovativeness to prosper, rigor and discipline must accompany the process. For years hundreds of thousands of patents for new products and technologies lay fallow in government and university research labs because there was no commercial discipline. Entrepreneurship requires a bias toward action and a sense of urgency, but also demands patience and perseverance. While his competitors were acquiring and expanding rapidly, one entrepreneur's management team became nearly outraged at his inaction, This

Chapter 2 The Entrepreneurial Process

entrepreneur reported he saved the company at least $50--100 million during the prior year by just sitting tight, a lesson learned from the Jiffy Lube case series from NVC, which he studied during a week-long program for the Young Presidents Organization (YFD) at Harvard Business School in 1991.

The greater the organization, orderliness, discipline, and control, the less you will control yourultirnate destiny. Entrepreneurship requires great flexibility and nimbleness in strategy and tactics. One has to play with the knees bent. Over-control and an obsession with orderliness are impediments to the entrepreneurial approach. As the great race car driver, Mario Andretti said: "If I am in total control, I mow I am going too slow1"lO

Adhering to management best practice, especially staying close to the customer, that created industry leaders in the 1980s, became a seed of self-destruction and loss of leadership to upstart competitors. We discussed earlier the study of" disruptive technologies."

In order to realize long-term equity value, you have to forgo the temptations of short-term profitability, BUilding long-term equity requires major continuing reinvestment in new people, products, services, and support systems, usually at the expense of immediate profits.

No doubt about it. The world of entrepreneurship is not one that is neat, tidy, linear, consistent, and predictable, no matter how much we might like it to be that way.ll These paradoxes illustrate just how contradictory and chaotic this world can be. To thrive in this world one needs to be very adept at coping with ambiguity, chaos, and uncertainty, and at building management skills that create predictability.

The Higher Potential Venture: Think Big Enough One of the biggest mistakes aspiring entrepreneurs make is strategic: They think too smalL Sensible as it may be to think in terms of a very small, simple business as being both more affordable, more manageable, less demanding, and less risky, the opposite is true, judging by the facts. Not only are the chances for survival and success lower in these small, jobsubstitute businesses, even if they do survive, they are less financially rewarding. As one founder of numer-

31

ous businesses put it: unless this business can pay you at least five times your present salary, the risk and wear and tear won't be worth it.

Consider one of the most successful venture capital investors ever, Arthur Rock. His criterion for searching for opportunities is very simple: Concepts for businesses that change the way people live or work. His home-run investments are legendary, including Intel, Apple Computer, Teledyne, and dozens of others. Clearly, his philosophy is to think big.

Today an extraordinary variety of people, opportunities, and strategies characterize the approximately 30 million enterprises of all kinds in the nation; proprietorships, partnerships and corporations. We saw earlier in Chapter 1 the unprecedented number of 3.5 million new businesses created per year in the United States, and that in 37 percent of the 35 million households in the country someone had a primary role in a new or small business, A 1997 Dun & Bradstreet report estimated the total number of corporations in 1996 at 9,900,088,12 Over 90 percent of these had revenues of less than $1 million annually, while 863,505 reported revenues of $1-25 million: or just over 9 percent of the total. Of these, only 296,695 grew at a compounded annual growth rate of 30 percent or more for the prior three years, or about 3 percent. Similarly, just 3 percent-l in 33--exceed $10 million in sales, and only .3 percent-l in 333- exceed $100 million in revenue.

Not only can nearly anyone start a business, a great many succeed, While it certainly may help, a person does not have to be a genius to create a successful business. As Nolan Bushnell, founder of Atari, one of the first desktop computer game companies in the early 1980s, and Pizza Time Theater, has said: "If you are not a millionaire or bankrupt by the time you are 30 you are not really trying!,,13

While we saw earlier the stunning number of mega-entrepreneurs who launched their venture during their twenties, the rigors of new ventures may favor the "young at start." But age is no barrier to entry. One study showed that nearly 21 percent of founders were over 40 when they embarked on their entrepreneurial careers, the majority were in their 305, and just over one-quarter did so by the time they were 25. Further, numerous examples exist of founders who were over 60 at the time of launch, ineluding one of the most famous seniors, Colonel Harland Sanders, who started Kentucky Fried Chicken with his first social security check.

10 My special thanks to Professor Stephen Spinelli for this wonderful quote.

II See Howard H Stevenson. Do Lunch or Be LutiCh, 1998, Harvard Business School Press, (Cambridge. MA.), for a provocative argument for predictability as one of the most powerful of management tools.

The following percentages of small businesses are dissolved within two, four, and six years:

Within two years

With info ur years

Within six years

Reasons for Failure

A breakdown of why businesses fail:

Economic factors

Financial troubles!

Inexperience

62.7%

70

Percent

47.4%

Owner neglect2

lind uding excessive debt and operating expenses, or insufficient working capital 21 ncluding business conflicts, family problems, poor work habits

Other3

3lncluding disasters and fraud

o

10

20

Percent

30

40

50

60

70

Note: A "dissolved" business includes those that are voluntarily shut down as well as those forced to fire for bankruptcy. Source: The Wail Street Journal, October 16,1992, p. R7.

Smaller Means Higher Failure Odds

Unfortunately, the record of survival is not good among all firms started.

For the vast majority of new businesses in the country, the odds of survival definitely are not in their favor. While government data, research, and business mortality statisticians may not agree on the precise failure and survival figures for new businesses, they do agree that failure is the rule, not the exception.

Complicating efforts to obtain precise figures is the fact that it is not easy to define and identify failure~, and reliable statistics and databases just are not available, However, the Small Business Administration estimated in 1983 that for everv three new businesses formed, two close their door~.14

There is also wide variation in failure rates across industries. In 1991, for instance, even though retail and services accounted for two of nine categories reported in The State of Small Business, they accounted for 61 percent of all failures and bankruptcies in that year. 15

Exhibit 2.1 is a distillation of a number of studies of failure rates over the last 50 years. Illustrated are the facts that (1) failure rates are high and (2) although the majority of the failures occur in the first two to five years, it may take considerably longer for some to fail. This picture is supported by the findings of several different studies.I6

To make matters worse, most people think that the failure rates are actually much higher. Since most would argue that actions are governed, more often than not, by perceptions rather than facts alone, this

perception of failure, in addition to the dismal record, can be a serious obstacle to aspiring entrepreneurs.

Still other studies have shown significant differences in rates of survival and failure among different types of businesses. For instance, just 3 of 21 Dun & Bradstreet categories accounted for 70 percent of all failure and bankruptcies: retail trade, construction, and small service businesses. Further, 99 percent of these had fewer than 100 employees. Through observation and practical experience one would not be surprised by such reports. The implications for would-be entrepreneurs are important: Knowing the difference between a good idea and a real opportunity is vital. This will be addressed in Chapter 3.

A certain level of failure is part of "creative selfdestruction" described by Joseph Schumpeter. It is part of the dynamics of innovation and economic renewal, a process which requires both births and deaths.

More important, it is also part of the learning process inherent in gaining an entrepreneurial apprenticeship. If a business fails, no other country in the world has laws, institutions, and social norms that are more forgiving. Firms go out of existence, but entrepreneurs survive and learn.

This daunting evidence poses two important questions for aspiring entrepreneurs. First, are there any exceptions to this general rule of failure, or are we faced with a punishing game of entrepreneurial roulette? Second, if there is an exception, how does one get the odds for success in one's favor?

Getting the Odds in Your Favor

Fortunately, there is a decided pattern of exceptions to the overall rate of failure among the vast majority of small, marginal firms created each year. Most smaller enterprises that cease operation Simply do not meet our notion of entrepreneurship: They do not create, enhance, or pursue opportunities that realize value. They tend to be job substitutes in many instances. Undercapitalized, unmanaged. and often poorly located, they soon fail.

Threshold Concept

Who are the survivors? The odds for survival and a higher level of success change dramatically if the venture reaches a critical mass of at least 10 to 20 people and $2-3 million in revenues, and is pursuing opportunities where there is grmvth potential. Exhibit 2.2 shows that based on a cross-section of all new firms, one-year survival rates for new firms jump from

33

approximately 78 percent for firms having up to 9 employees to approximately 95 percent for firms with between 20 and 99 employees.

A 1991 study found that "empirical evidence supports the liability of newness and liability of smallness arguments and suggests that newness and small size make survival problematic;" the authors inferred that "perceived satisfaction, cooperation, and trust between the customer and the organization [are] important for the continuation of the relationship. High levels of satisfaction, cooperation, and trust represent a stock of good\vill and positive beliefs which are critical assets that influence the commitment of the two parties to the relationship.,,17 It is interesting that the authors of this study noted that "smaller organizations are found to be more responsive, while larger organizations are found to provide greater depth of service .... The entrepreneurial task is to find a way to either direct the arena of competition away from the areas where you are at a competitive disadvantage, or find some creative way to develop the required competency.'v''

After four years, as shown in Exhibit 2.3, the survival rate jumps from approximately 37 percent for

EXHIDIT2.2

One-Year Survival Rates by Firm Size

Firm Size (employees)

Survival Percent

0-9 10-19 20--99 100-249 250+

77.8% 85.5 95.3 95.2

100.0

Source: Michael B Teitz et al., "Small Business and Employment Growth in California," Working Paper No. 348. University of California at Berkeley, March 1981, p. 42.

Although allY 4 'stimates based on sales per employee vary (;01 1,.id1 -rably from industry to industry, this minimu: n I" n -shold translates roughly to a threshold of $:JO,1l1l0 to $100,000 of sales per employee annually II'll highly successful firms can generate much higll! 'I' sales per employee.

Promise of Growth

!he definitio~1 1'1' ('111 repreneurship implies the promise of expansiou alld the building of long-term value and durable cash llo\\' streams as well.

But, as will hi' discussed later, it takes a long time for new COlll~Xllli('s to become established and grow. A ~~<~l .B~lsl1H.'ss\dministration study, summarized III Exlllbit _ . .J. l 0\. "I'lng the period from 1976 to 1986, found that two til 4 'verv five small firms founded sur\i\'~d six ()1· .. ttllH~' \ vars but that few achieved growth (!lln~lg the fIrst I, '111 ~ears.19 The study also found that sUl'\wal rates uu 11,' than double for firms which grow and tln- t'arlier 1\\ I h~, life of the business that grov.1:h OC'Clll'S, the hi)!;hl't (he chance of SUIVl'V' I en

01 I' ,t.

I I(ll'r.l<lta ,I!.", confirm this exceIllion A study

( 1I1h" nv lye ,II lb'

. ' '. ~ "\I ~ t rat, etween 1982· 1198- th

;(\'(-r:I",' "r' tl les of ,III( I, e

... ... ()\\ 1 III q es of the INC. !jon Was 96 per-

cent per year. The study also finds that, of the 7 million corporations in the United States, approximately 7 percent (just under 500,000 firms) grew over 20 percent per year and just over 1 percent (approximately 80,000 firms) grew 50 percent per year.

Some of the true excitement of entrepreneurship lies in conceiving, launching, and building firms such as these.

Venture Capital Backing

Another notable pattern of exception to the failure rule is found for businesses which have attracted startup financing from successful private venture capital companies. Instead of the 70 percent to 90 percent failure rate shown when ail types of new firms are considered, these new ventures enjoy a survival rate nearly that high.

Studies of success rates of venture capital portfolios, summarized in Exhibit 2.5, show that in the portfolios of experienced professional venture capital firms, typically about 15 percent to 20 percent of the companies will result in total loss of the original investments and, further, that it is unusual for the loss rates for portfolios of experienced venture capital firms to exceed 30 percent to 35 percent and for the loss rates to fall below 10 percent.21

According to Venture Economics (1988), more than one-third of 383 investments made bv 13 firms between 1969 and 1985 resulted in an abs~lute loss. More than two-thirds of the individual investments made by these same firms resulted in capital returns ofless than double the original cost. Nevertheless, the returns on a few investments have more than offset these disappointments. Venture Economics reports, for example, that 6.8 percent of the investments resulted in payoffs greater than 10 times cost and yielded 49.9 percent of the ending value of the aggregate portfolio (61.4 percent of the profits).22 Even higher returns have been achieved by such spectacular successes as Apple Computer, Lotus, Digital Equipment, Inte1, Compaq, and the like.

It is clear that venture capital is not essential to a startup, nor is it a guarantee of success, as is evident in the following statistics: only 5 percent of the INC. 500 have venture funding and merely 1 percent of all new companies have venture funding. Consider, for instance, that "in 1987-a banner year-venture capitalists financed a grand total of 1,729 companies, of which 112 were seed financings and 232 were startups. In that same year, 631,000 new businesses incor-

, 23

porations were recorded.

This compelling data has led some to conclude that there is a threshold core of 10 percent to 15 percent of new companies which will become the winners in terms of size, job creation, profitability, innovation, and potential for harvesting (and thereby realizing a capital gain). Eventually, from among these 10 percent to 15 percent of all new firms emerge the "winning performers. ,,24 As shown in Exhibit 2.6, the top 25 percent among all medium-sized companies achieved records of growth from 1978 to 1983 that exceeded the growth of the top quarter of the economy, the top quarter of the Fortune 500 and firms classified as "excellent companies."

Not Only the Insights of Venture Capitalists

Harvested entrepreneurs by the tens of thousands have become "Angels" as private investors in the next generation of entrepreneurs. Many of the more successful have created their own investment pools and compete directly with venture capitalists for deals. Their operating experiences and successful track records provide a compelling case for adding value to an upstart company. Take, for example, highly successful Boston entrepreneur Jeff Parker. His first venture, Technical Data Corporation, was the first to enable Wall Street bond traders to conduct daily trading with a desktop computer. Parker's software on the Apple II created an entirely new industry in the early 19805.

Afte; harvesting this and other ventures, he created his own private investment pool in the 1990s. As the Internet explosion occurred, he was one of the early investors to spot opportunities in startup ventures. In one case, he actually persuaded the founders of a new Internet firm to select him as lead investor, instead of offers from some of the most prestigious venture capital firms in the nation. How could this be? According to the founders, it was clear that Parker's unique entrepreneurial track record and his understanding of their business would add more value than the venture capitalists at startup.

Private investors and entrepreneurs like Parker have very similar selection criteria to the venture capitalists: they are in search of the high-potential, higher growth ventures. Unlike the venture capitalists, however, they are not constrained by having to invest so much money in a relatively short period of time that they must invest it in minimum chunks of $3-,5 million or more. Thus, such private investors are prime sources for less capital-intensive startup and early stage businesses.

If anything, this overall search for higher potential ventures has become even more evident in recent years. The new E-Generation appears to be learning the lessons of these survivors, venture capitalists, private investors, and founders of higher potential firms. Certainly hundreds of thousands of college students now have been exposed to these concepts for over two decades, and their strategies for identifying potential businesses are mindful and disciplined about the ingredients for success. Unlike 20 years ago, it is now nearly impossible not to hear and read these principles whether on television, in books, on the Internet or in a multitude of seminars, courses, and progr;ms for would-be entrepreneurs of every sort.

find Financial Backers and Associates Who Add Value

One of the most distinguishing disciplines of these higher potential ventures is how the founders identify financial partners and key team members. They insist on backers and partners who do more than bring just money, friendship, commitment, and motivation to the venture, They surround themselves with backers who call add vah;e to the venture through their expent'nee, 1, now-how, networks, and wisdom. Key associatps an' ',r~lected becallse they are smarter than the I( Hlnd( r :lrp hett('r at what they do than the founder, . 111.1 I II' I lu- fl\'('rall ;l\'pra!;!' of thp entire company,

[ I" •••• "11)(. ,·\.11I1ill(·<\ ill dr'taillatpr on. '

Option: The Lifestyle Venture

For many aspiring entrepreneurs, issues of family roots and location take precedent. Accessibility to a preferred way of life, whether it is fly fishing, skiing, hunting, hiking, music, surfing, rock climbing, canoeing, a rural setting, the mountains, you name it, simply is more important than how large a business one has. or the size of one's net worth. Others vastly prefer to be with and work with their family and spouse and live in a non urban area they consider very attractive, Take Jake and Diana Bishop, for instance. Both college educated with masters' degrees in accounting, they gave up six-figure jobs they both found rewarding and satisf\.ing on the beautiful coast of Maine. Why? They decided to return to their home state of Michigan for several important lifestyle reasons. They wanted to work together again in a business (which they say was the best former period of their marriage). It was important to be much closer than the 14-hour drive to Diana's aging parents. They also wanted to have their children-then in their twenties-join them in the business. Finally, they wanted to live in one of their favorite areas in the entire country, Harbor Spring, on the northwest tip of the state on Lake Michigan. They report never to have worked any harder in their 50 years, nor have they been any happier. They are growing their rental business more than 20 percent a year, making an excellent Ihing, and creating equity value . If done right it turns out that one can have a lifestyle husinpss and actually realize higlwr potential.

Chapter 2 The Entrepreneurial Process

Yet it is generally known that couples who give up successful careers in New York City to buy an inn in Vermont or New Hampshire to avoid the rat-race last only six to seven years. They discover the joys of selfemployment; including seven-day, 70-90 hour work weeks, chefs and day help that don't show up, roofs that leak when least expected, and occasional guests from hell. The grass is always greener, so they say.

The Timmons Model: Where Theory and Practice CollJtle in the Real World25

What is going on here? How can aspiring entrepreneurs-and the investors and associates who join the venture-get the odds on their side? What do these talented and successful high-potential entrepreneurs, their venture capitalists and private backers do differently? What is accounting for their exceptional record? Are there general lessons and principles underlying their successes that can benefit aspiring entrepreneurs, investors, and those who would join a venture? If so, can these lessons be learned?

These are the central questions of the author's lifetime work, originating during MBA and doctoral work in the late 1960s. Over the past 30 years, beginning with doctoral research, I have been immersed as a student, researcher, teacher, and practitioner of the entrepreneurial process. As a founding shareholder and investor of several high-potential ventures (some of which are now public), as a director and advisor to ventures and venture capital funds, and as a charter director and advisor to the Kauffman Center for Entrepreneurial Leadership at the Ewing Marion Kauffman Foundation, I have applied, tested, refined, and tempered academic theory as fire tempers iron into steel: in the fire of practice.

Intellectual and Practical Collisions with the Real World

Throughout this period of evolution and revolution, New Venture Creation has adhered to one core principle: In every quest for greater knowledge of the entrepreneurial process and more effective learning there must be intellectual and practical collisions between academic theory and the real world of practice. The standard academic notion-That may be all right in practice, but does it work in theory?-is simply not acceptable. This integrated, holistic balance and juggling act is at the heart of what we know

37

about the entrepreneurial process and getting the odds in your favor.

Value Creation: The Driving Forces

The conclusion to those central questions has boiled down to this: a core, fundamental entrepreneurial process accounts for the substantially higher success pattern among higher potential ventures. Despite the great variety of businesses, entrepreneurs, geography, and technology, time and again central themes dominate this highly dynamic entrepreneurial process. What are these driving forces?

• It is Opporlunity driven.

• It is driven by a Lead Entrepreneur and an Entrepreneurial Team.

• It is Resource Parsimonious and Creative.

• It depends on the Fit and Balance among these.

• It is Integrated and Holistic.

These are the controllable components of the entrepreneurial process that can be assessed, influenced, molded and altered, thereby changing in positive ways the risk-to-reward equation. Throughout the careful due diligence process conducted by prospective investors, and by the founders, these themes are the focus in analyzing the risks and tradeoffs and determining what can be changed, added, deleted, or reconfigured to improve the fit and balance and thereby get the odds in one's favor.

First, we will elaborate on each of these themes to provide a blueprint and a definition of what each means. Then using Netscape as an example, we will illustrate the holistic, balance, and fit aspects.

Change the Odds: Fix It, Shape It, Mold It, Make It The driving forces underlying successful new venture creation are illustrated in Exhibit 2.7.26 The process starts with opportunity, not money, not strategy, not networks, not the team, not the business plan. Most genuine opportunities are much bigger than either the talent and capacity of the team or the resources available to the team at the outset. The role of the lead entrepreneur and the team is to juggle all of these key elements in a dynamic, moving environment. Think of a juggler bouncing up and down on a trampoline that is moving on a conveyor belt at unpredictable speeds and directions, while trying to keep all three balls in the air. That is how dynamic it can be. The business plan provides the language and

~, I succumb to the urging of my colleagues. especiallv Professor Stephen Spin .. Ilt, and refer to the conceptual framework as the" do.

code for communicating the quality of the three driving forces and of their fit and balance.

The lead entrepreneur's job is simple enough: he or she must cany the deal by taking charge of the success equation. In this dynamic context, ambiguity and risk are actually vour friends. Central to the homework, creative problem-solving and strategizing, and due diligence that lies ahead is analyzing just what are the fits and gaps that exist in the venture. What is wrong with this opportunity? What is missing? What good news and favorable events can happen, not just the adverse? What has to happen to make it attractive and fit me? What market, technology, competitive, management and financial risks can be reduced or eliminated? What can be changed to make this happen? Who can change it? What are the least resources necessary to get this the farthest? Is this the right team? And so on. By implication, if one can determine these answers, make the necessary changes and additions, figure out how to fill the gaps and improve the fit, and/or attract key players who can add such value, then the odds for success rise significantly. In essence, the entrepreneur's role is to manage and redefine the risk-reward equation.

The Opportunity At the heart of the process is the opportunity. Successful entrepreneurs and investors know that a good idea is not necessarily a good opportunity. In fact, for every 100 ideas presented to investors. in the fonn. of a business plan or proposal of some kind, usually Just 1 or sometimes 2 or 3 ever get funded. Over 80 percent of those rejections occur in the first few ~ours; another 10 to 15 percent are rejected after Investors have read the business plan

,.:,~'I)'''''rr~'''''Ur1-~·I)\1;m,~al. r tC \

as .omrmll(, Ft· ,rn"TV-March 1997. pp. 82-84.

carefully. Less than 10 percent attract enough interest to merit thorough due diligence and investigation over several weeks, and even months. Those are very slim odds. Countless hours and days have been wasted by would-be entrepreneurs chasing ideas that are going nowhere. An important skill, therefore, as an entrepreneur or an investor, is to be able to size up quickly whether serious potential exists, and to decide how much time and effort to invest.

John Doerr is a 48-year-old partner at one of the most famous and successful venture capital funds ever, Kleiner, Perkins, Caulfield & Byers, and by all accounts, the most influential venture capitalist of his generation, according to Fast Company. During his 18-year career he has been the epitome of the revolutionaries described earlier who have created new industries as lead investor in such legends as Sun Microsystems, Compaq Computer, Lotus Development Corporation, Intuit, Genentech, Millennium, Netscape, and Amazon.Com. Regardless of these past home-runs, Doerr insists:

There's never been a better time than now to start a company. In the past, entrepreneurs started businesses. Today they invent new business models. That's a big difference, ~d it creates huge opportunities.f"

Exhibit 2.8 summarizes the most important characteristics of good opportunities. Underlying market demand-because of the value-added properties of the product or service, the market's size and 20+ percent growth potential, the economics of the business, particularly robust margins (40 percent or more), and free cash flow characteristics--drives the value creation potential.

~~.- ._-- _----------------

Chapter 2 The Entrepreneurial Process

EXUmrr2J]

The Entrepreneurial Process is Opportunity Driven

Market demand is a key ingredient to measuring an opportunity:

• Is the customer reachable?

• Customer payback less than one year

• Market share and growth potential equals

• 20 percent annual growth, 20 percent + and durable?

Market structure and size:

• Emerging and/or fragmented?

• $50 mill ion + with a $1 billion potential?

• Proprietary barriers to entry?

Margin analysis helps differentiate an opportunity from an idea:

• Low cost provider? (40 percent gross margin)

• Low capital requirement versus the competition?

• Break even in 1-2 years?

• Value added increase of overall corporate PIE ratio?

These criteria will be described in great detail in Chapter ,,) and can be applied to the search and evaluation of any opportunity. In short, the greater the growth, size, durability, and robustness of the gross and net margins and free cash flow, the greater the opportunity, The more imperfect the market, the greater the opportunity. The greater the rate of change, the discontinuities, and chaos, the greater are the opportunities, as we saw with Moore's Law and Drucker's Postulate in Chapter 1. The greater the inconsistencies in existing service and quality, in lead times and lag times, and the greater the vacuums and gaps in information and knowledge, the greater the opportunities.

Resources: Creative and Parsimonious One of the most common misconceptions among untried entrepreneurs is that you first have to have all the resources in place, especially the money, in order to succeed with a venture. Thinking money first is a big mistake. Money follows high potential opportunities conceived of and led by a strong management team. Investors have bemoaned for years that there is too much money chasing too few deals. In other words, there is a shortage of quality entrepreneurs and opportunities, not money. Successful entrepreneurs devise ingeniously creative and stingy strategies in marshalling and gaining control of resources (Exhibit 2.9). Surprising as it may sound, investors and successful entrepreneurs often sav one of the worst things that can happen to an entrepreneur is to have I(l>! IIl/WII 1110/1('11 ti'(! 1'(/1'1,,"

39

IXHIBlJ2.IJ

Understand and Marshall Resources, Don't Be Driven by Them

Minimize and Control versus

Maximize and Own

Unleashing creativity

Financial resources Assets

People

Your business plan

Think cash last!

The best example of this the author has ever encountered is the late Howard Head, who developed the first metal ski, Head, which became the market leader, and then the oversize Prince tennis racket, two totally unrelated technologies-a rare feat. Head left his job at a large aircraft manufacturer during World War II and worked in his garage on a shoestring budget to create his metal ski. It took over 40 different versions before he succeeded in developing a ski that worked and could be marketed. He insisted that one of the biggest reasons he finally succeeded is that he had so little money. He argued that if he had complete financing he would have blown it all long before he evolved the workable metal ski.

Bootstrapping is a way of life in entrepreneurial companies and can create a significant competitive advantage. Doing more with less is a powerful competitive weapon, as we saw in Chapter 1 as upstart Cellular One outperformed NYNEX three-to-one, with one-half to one-third the resources. Their approaches are to minimize and control the resource, not necessarily own the resource. Whether it is assets for the business, key people, the business plan, or startup and growth capital they think cash last. Such strategies have a wondrous effect on the company in two ways: a discipline of leanness, where everyone knows that every dollar counts and permeates the firm; and, the principle of CYE-Conserve Your Equity-e-becomes a way of maximizing shareholder value. The resource dimension will be discussed later. along with the business plan, in Chapters 10 and 11.

The Entrepreneurial Team There is little dispute today that the entrepreneurial team is a key ingredient in the higher potential venture. Investors are captivated "by the creative brilliance of a company's head entrepreneur: A Mitch Kapor, a Steve [ohs. a Fred Smith ... and lwt ()ll Ill(' '11])('r\1 I r:\d, n'('ill'll, Ill' IIii'

40

Part I The Opportunity

management team working as a group.,,28 Venture capitalist John Doerr reaffirms father of American venture capital General. George Doriot's dictum: I prefer a Grade A entrepreneur and team with a Grade B idea, over a Grade B team with a Grade A idea.

In the world today, there's plenty of technology, plenty of entrepreneurs, plenty of money, plenty of venture capital. What's in short supply is great teams. Your biggest challenge will be building a great team.29

Famous investor Arthur Rock articulated the im-

portance of the team over a decade ago. He put it this way: "If you can find good people, they can always change the product. Nearly every mistake I've made has been I picked the \wong people, not the wrong idea:030

Finallv, as we saw earlier, the ventures with more than 20 .emplovees and 82-3 million in sales were much more likely to survive and prosper. In the vast majority of cases, it is very difficult to grow beyond this without a team of hila or more key contributors.

Exhibit 2.10 depicts the important aspects of the team. Make no mistake about it, these teams invariably are formed and led by a very capable entrepreneurial leader whose track record exhibits both accomplishments and many of the qualities that the team must possess. A pacesetter, culture-creator, and player/coach; the lead entrepreneur is central. The ability and skill in attracting other key management members and then building the team is one of the most valued capacities investors look for. The founder who becomes the leader does so by bUilding heroes in the team; by a philosophy that rewards success and supports honest failure, that shares the wealth with those who help create it; and by setting high standards for both performance and conduct. We will examine in detail the entrepreneurial leader and the new venture team in Chapters 6, 7, and 8.

Importance of Fit and Balance Rounding out the model of the three driving forces is the concept of fit and balance. Note that the team is positioned at the bottom of the triangle in Exhibit 2.7. Imagine the founder, entrepreneurial leader of the venture standing on a large ball, grasping the triangle over her head.31 The challenge is to balance the balls above her head, without toppling off. This imagery is helpful in appreciating the constant balancing act from the outset, since rarely, if ever, are the three ingredients matched. When envisioning a company's future using this imagery, the entrepreneur can ask herself,

EXHlBIT2..lO

An Entrepreneurial Team Is the Key Ingredient for Success

An entrepreneurial leader

• learns and teaches-faster, better

• Deals with adversity, is resilient

• Exhibits integrity, dependability, honesty

• Builds entrepreneurial culture and organization

Qua I ity of the team

• Relevant experience and track record

• Motivation to excel

• Commitment, determination, and persistence

• Tolerance of risk, ambiguity, and uncertainty

• Creativity

• Team focus of control

• Adaptability

• Opportunity obsession

• Leadership

• Communication

What pitfalls will I encounter to get to the next boundary of success? Will my current team be large enough, or will we be over our heads if the company grows 30 percent over the next two years? Are my resources sufficient (or too abundant)? Vivid examples of the failure to maintain a balance are everywhere, such as when large companies throw too many resources at a weak, poorly defined opportunity. The Ford Motor Company's launching of the Edsel is just one example from a very large list.

Exhibit 2.11(a) through (d) show how this balancing act evolved for Netscape from inception through the initial public offering to today. While the drawings oversimplify these incredibly complex events, they help us to think conceptually-an important entrepreneurial talent-about the company building process, the strategic and management implications in striving to achieve balance, the leads and lags, the inevitable fragility of the process.

Clearly, the Internet was a huge, rapidly growi.ng, but elusive opportunity. Mark Andressen had no significant capital or other resources to speak of. There was no team. One can envision how quickly such a mismatch of ideas, resources, and talent could qUickly topple out of the founder's control, and, most likely, fall into the hands of someone who could turn it into a real opportunity. Visually, the process can be appreciated as a constant balancing act, reqUiring continual

Netscape-Journey through the Entrepreneurial Process At Startup, a huge imbalance

Communication

Opportunity Very large, growing and undefined

Business pIa n

•

/ /

/

/ Exogenous forces

/

/

/// ......

...... Leadership

Ambiguity

Fits and gaps

• Innumerable: Money and management

Creativity

Uncertainty

Ca p ita I mar ket con text

Founder

EXHIIIIT 2.IUDI

Netscape-Journey through the Entrepreneurial Process At venture capital funding, toward new balance

/

Fits and gaps / /

• Resources and team /

Ambiguity " Exogenous forces

" • Catching up / /

....... -, / ......

Creativity .,.... -, G / ...... leadership

" Team / .

Capital market context

-

unc:::lnty ..

Founder

Communication

•

Business plan

assessment, revised strategies and tactics, an experimental approach. By addressing the types of questions necessary to shape the opportunity, the resources, and the team, the founder begins to mold the idea into an opportunity, and the opportunity into a business, just as you would mold clay from shapeless form to a piece of artwork.

At the outset, founder Marc Andressen would have seen something like the first figure, Exhibit 2.11(a), with the huge Internet opportunity far outweighing

the team and resources. Needless to say, the gaps were major. Enter venture capitalist John Doerr, et. al.. the first venture capitalist to vividly see the size and potential of the opportunity. He had great faith in Andressen, and knew he could fill the resource gaps and help build the team, both with inside management and outside directors and professional advisors. This new balance 2.11(b) creates a justifiable investment. The opportunity is still huge and growing, and competitors are inevitable 2.11 (c L To fully exploit this

42

Part I The Opportunity

EXIIlRIT 2.ntrl

Netscape-Journey through the Entrepreneurial Process At IPO, a new balance

opportunity, attract a large and highly talented group of managers and professionals, and to create even greater financial strength vs, competitors, the company must complete an initial public stock offering (IPO).

Netscape today, 2.11(d), is larger, stronger in people and resources, but faces new challenges. As we saw in Chapter 1 there is an overwhelming tendency for even the best and brightest of new firms-from IB~L to Digital Equipment Corporation to Apple Computer-to erode over two or more decades into Brontosaurus Capitalism. Can Netscape sustain and reinvent its entrepreneurial roots and organization, as the opportunity continues to mushroom and competition for markets, people, and technology are greater than ever'? wm it become blindsided and eclipsed by a new disruptive technology, just as Apple Computer and Microsoft bludgeoned IBM and Digital Equipment. Is Netscape today a new candidate for the next installment of Brontosaurus Capitalism, and if so, when will this occur? These, of course, are questions that rob management and the board of directors of much sleep.

This iterative entrepreneurial process is both logical and trial and error. It is both intuitive and consciouslv planned. It is a process not unlike what the Wright brothers originally engaged in while creating the first self-propelled airplane. They conducted over 1,000 glider flights before succeeding with the Wright Flyer. These were the trial and error experiments that led to the new knowledge, skills, and insights needed in order to actually fly. Entrepreneurs have similar leaming curves.

EXIlIBIT 2.12

Fit of Entrepreneur and Venture Capital

The Fit issue can be appreciated in terms of a question: this is a fabulous opportunity, but for whom? It is well known that some of the most successful investments ever were actuallv turned down by numerous investors before the fou~ders received backing. Time and again, there can be a mismatch between the type of business, the chemistry between founders and backers, or a multitude of other factors that can cause a rejection. Thus, how the uniqur. combination of people, opportunity, and resources come together at that particular time and space may be the most important factor in a venture's ultimate chance for success. How else could one explain Intuit's 20 rejections by sophisticated investors for startup funding?

The potential for attracting outside funding for a proposed venture depends on this overall fit, and how the investor believes he or she can add value to this fit, improve the fit, risk-reward ratio and odds for success. Exhibit 2.12 shows the possible outcomes.

Importance of Timing Equally important is the timing of all these entrepreneurial events. Each of these unique combinations occurs in real time, where the hourglass drains continually, and may be friend, foe or both. Decisiveness in recognizing and seizing the opportunity can make all the difference, particularly when the sand disappearing from the hourglass is cash. In fact, there is no such thing as a perfect time for an opportunity. Most new businesses run out of money before they can find enough customers and the right team for their great idea. Opportunity is a moving target.

High

low

Potential for Singles Potentia! for triples
or doubles, but may and home runs
strike out
Not hat a nd no cattl e Big hat. no cattle ~

C ::J

1:: 8.

0. o

~

::J

C

ill ;>

'" U)

ill C al .2:

ti g

~

Low

Entrepreneur's fit and balance

(Minu-set. know-how, revelant experience, and track record of team and resources)

High

- '

, t ". ..._ ,","p'," '

44

Part I The Opportunity

Recent Research Supports the Model

The Timmons Model originally evolved from doctoral dissertation research at the Harvard Business School about new and growing ventures. Over nearly three decades it has evolved and has been enhanced by ongoing research, case development, teaching and the author's hands-on experience in high-potential ventures and venture capital funds. The fundamental components of the model have not changed, but their richness and the relationships of each to the whole has been enhanced steadily, as they have become better understood. Numerous other researchers have examined a wide range of topics in entrepreneurship and new venture creation. The bottom line of all this is that the model, in its simple elegance and dynamic richness, harnesses what you need to know about the entrepreneurial process: and getting the odds in your favor. As each of the chapters, and accompanying cases, exercises, and issues elaborates the process and addresses individual dimensions, a detailed framework and explicit criteria will emerge. If you engage this material fully you cannot help but improve your chances.

Quite recently, a major new research effort was conducted by the National Center for Entrepreneurship Research at the Kauffman Center for Entrepreneurial Leadership with a specific focus on 906 highgrmvth companies.32 These findings provide important benchmarks of the practices in a diverse group of industries, among a high performing group of companies who were regional and national award winners in the Ernst & Young LLP Entrepreneur of the Year Program. These firms increased their sales from 1994 to 1996 on average by 28 percent, compared to an increase of just 15 percent for the Fortune 500 companies. One-third of these firms have less than 810 million in sales, most were in the 825-75 million range, were quite profitable, one-fifth had fewer than 49 employees, and over half had 50 to 499 employees. Over half had less than $9.9 million in assets, and about half had assets of $3 to $49.9 million.

Most Significantly, these results reconfirm the importance of the model and its principles: the team. the market opportunity, the resource strategies, nwst of the tndtcidual criteria, and the concept of fit and balance. and the holistic approach to entrepreneurship.

Summarized in Exhibit 2.13 are the 26 leading

practices identified in four key areas: Marketing, Fi-

nancial, Management and Planning. (A complete version of the study is available from the National Center for Entrepreneurship Research. Kauffman Center for Entrepreneurial Leadership, Kansas City,

MO 64112.) ,

Enlrepreneurial Reasoning:

The Entrepreneurial Mind33 in Arlion

Most research about entrepreneurs has focused on the influences of genes, family, education, career experience, and so forth, but no psvchological model has been supported. Successful entrepreneurs seem to be of both sexes and in every imaginable size, shape, color, and description. Perhaps one Price-Babson College fellow phrased it best when he said, "One does not want to overdo the personality

stuff, but there is a certain ring to it. ".34 '

However, the real question is, What do success fill entrepreneurs do? That is, how do they think, what actions do they initiate, and how do they go about starting and bUilding businesses? The result is what counts, and by understanding the attitudes. behaviors, management competencies, experience, and know-how that contribute to entrepreneurial success, one has some useful henchmarks for gauging what to do and what to do differently.

Successful entrepreneursshare common attitudes and behaviors. They work hard and are driven bv an intense commitme~t and determined perseverance: they see the cup halffull, rather than half empty, they strive for integrity; they burn with the competitive d~sire to excel and win; they are dissatisfied with the status quo and seek opportunities to improve almost any situation they encounter; they use failure as a tool fo'r learning and eschew perfection in favor of effectiwness; and they believe they can personally make an enormous difference in the final outcome of their ventures and their lives.

Those who have succeeded speak of these attitudes and behaviors time and again.:35 For example, two famous entrepreneurs have captured the intense commitment and determined perseverance of entrepreneurs. Wally Amos, famous for his chocolate chip cookies, said. "You can do anything Y01l want to do.'":3(> And John Johnson of Johnson Publishing Company

• Deliver products and services that are perceived as highest quality to expanding segments.

• Cultivate pace-settingnew products and services that stand out in the market as best of the breed.

• Deliver product and service benefits that demand average market or higher pricing .

• Generate revenue flows from existing products and services that typically sustain approximately 90% of the present revenue base while achieving flows from new products and services that typically expand revenue approximately 20% annually .

• Generate revenue flows from existing customers that typically sustain approximately 80% of the ongoing revenue base whi Ie achieving flows from new customers that typically expand revenue flows by about 30% annua!ly.

• Create high-impact new product and service improvements with development expenditures that typically account for no more than approximately 6% of revenues.

• Utilize a high-Yielding sales force that typically accounts for approximately 60% of marketing expenditures.

• Share with employees periodic planned versus actual performance data that is directly linked to the business plan

• Link job performance standards that have been Jointly set by management and employees to the business plan.

• Prospectively model the firm based on benchmarks that exceed industry norms, competitors and the industry leader.

(publisher of Ebony) expressed it this \Va)': "You need to think yourself out of a corner; meet needs, and

. .r

never, never accept no for an answer." ,

It seems that entrepreneurs who succeed possess not only a creative and innovative flair and other attitudes and behaviors but also solid general management skills, business know-how, and sufficient contacts. Exhibit 2.14 demonstrates this relationship.

Inventors, noted for their creativity, often lack the necessary management skills and bu'siness know-how. Promoters usually lack serious general management and business skills and true creativity. Administrators govern, police, and ensure the sm~oth operation of the status quo; their management skills, while high, are tuned to efficiency as well, and creativitv is usuallv not required. Although the management slalls of th~

manager and the entrepreneur overlap, the manager is more driven by conservation of resources and the entrepreneur is ~ore opportunity-driven.P

Apprenticeship: Acquiring the 50,000 Chunks During the past several years, studies about entrepreneurs have tended to confirm what practitioners have known all along: That some attitudes, behaviors, and know-how can in fact be acquired and that some of these attributes are more desirable than others?}

Increasingly, evidence from research about the career paths of entrepreneurs and the self-employed suggests that the role of experience and know-how is central in successful venture creation.t" Evidence also suggests that success is linked to thoughtful preparation and planning." This is what getting the 50,000 chunks of experience is all about.

Most successful entrepreneurs follow a pattern of apprenticeship, where they prepare for becoming entrepreneurs by gaining the relevant business experiences from parents who are self-employed or through job experiences. They do not leave acquisition of experience to accident or osmosis. As entrepreneur Harvey "Chef' Krentzman has said, "Know what you

know :md what you don't know." .

Role Models

Further, there is no more powerful teacher than a good example. Numerous studies show a strong connection between the presence of role models and the

emergence of entrepreneurs. For instance, one recent study showed that over half of thos~ startinA: new businesses had parents who owned businesses, The authors summarized it this way:

People who start companies are more likely to come from families in which their parents or close relatives were in business for themselves. These older people were examples, or "models," for the children. Whether they were successful or not probably didn't matter. However, for the children growing up in such a family. the action of starting a new business seems possible-something they can do.

Myths and Realilies

Folklore and stereotypes about entrepreneurs and entrepreneurial success are remarkably durable, even in these informed and sophisticated times. More is known about the founders and the process of entrepreneurship than ever before.

However, certain myths enjoy recurring attention and popularity. Part of the problem is that while generalities may apply to certain types of entrepreneurs and particular situations, the great variety of founders tend to defy generalization. Exhihit 2.15 shows myths about entrepreneurs that have persisted and realities that are supported by research.

Studies have indicated that 90 percent or more of founders start their companies in the same marketplace, technology, or industry they have been working in.43 Others have found that founders are likelv to have from 8 to 10 years of experience, and they are

Reality-Whi Ie entrepreneurs are born with certain native I ntell igence, a flair for creating, and energy, these talents by themselves are like unmolded clay or an unpainted canvas. The making of an entrepreneur occurs by accumulating the relevant skills, know-how, experiences, and contacts over a period of years and includes large doses of self-development. The creative capacity to envision and then pursue an opportunity is a direct descendent of at least 10 or more years of experience that lead to pattern recognition.

Myth 2-Anyone can start a business.

Reality-Entrepreneurs who recognize the difference between an idea and an opportunity, and who think big enough, start businesses that have a better chance of succeeding. Luck, to the extent it is Involved, requires good preparation. And the easiest part is starting up. What is hardest IS surviving, sustaining, and building a venture so its founders can realize a harvest. Perhaps only one in 10 to 20 new businesses that survive five years or more results in a capital gain for the founders.

Myth 3-Entrepreneurs are gamblers.

Reality-Successful entrepreneurs take very careful, calculated risks. They try to influence the odds, often by getting others to share risk with them and by avoiding or minimizing risks if they have the choice. Often they slice up the risk into smaller, quite digestible pieces; only then do they commit the time or resources to determme if that piece will work. They do not deliberately seek to take more risk or to take unnecessary risk, nor do they shy away from unavoidable risk.

Myth 4-Entrepreneurs want the whole show to themselves.

Reality-Owning and running the whole show effectively puts a ceiling on growth. Solo entrepreneurs usually make a living. It is extremely difficult to grow a higher potential venture by working single-handedly. Higher potential entrepreneurs build a team. an organization, and a company. Besides, 100 percent of nothing is nothing, so rather than taking a large piece of the pie, they work to make the pie bigger.

Myth 5-Entrepreneurs are their own bosses and completely independent.

Reality-Entrepreneurs are far from independent and have to serve many masters and constituencies, including partners, investors, customers, suppliers, creditors, employees, families, and those involved in social and community obligations. Entrepreneurs, however, can make free choices of whether, when, and what they care to respond to. Moreover, it is extremely difficult, and rare, to build a business beyond $1 million to $2 million in sales single-handedly.

Myth 6-Entrepreneurs work longer and harder than managers in big companies.

Reality-There IS no evidence that all entrepreneurs work more than their corporate counterparts. Some do, some do not. Some actually report that they work less.

Myth 7-Entrepreneurs experience a great deal of stress and pay a high price.

Realily-No doubt about it: Being an entrepreneur is stressful and demanding. But there is no evidence that it IS any more stressful than numerous other highly demanding professional roles, and entrepreneurs find their jobs very satisfying. They have a high sense of accomplishment, are healthier, and are much less likely to retire than those who work for others. Three times as many entrepreneurs as corporate managers say they plan to never retire.

Myth 8-Starting a business is risky and often ends in failure.

Reality-Talented and experienced entrepreneurs-because they pursue attractive opportun ities and are able to attract the right people and necessary financial and other resources to make the venture work-s-often head successful ventures. Further, businesses fail, but entrepreneurs do not. Failure is often the fire that tempers the steel of an entrepreneur's learning experience and street savvy.

Myth 9-Money is the most important start-up ingredient.

Reality-If the other pieces and talents are there, the money Will fellow, but it does not follow that an entrepreneur will succeed if he or she has enough money. Money is one of the least important ingredients In new venture success. Money is to the entrepreneur what the pal nt and brush are to the artist-an Inert tool which, in the right hands, can create marvels. Money is also a way of keeping score, rather than just an end in itself. Entrepreneurs thrive on the thrill of the chase; and, time and again, even after an entrepreneur has made a few mi Ilion dollars or more, he or she WI II work incessantly on a new vision to build another company.

Myth W-Entrepreneurs should be young and energetic.

Reality-While these qualities may help, age is no barrier, The average age of entrepreneurs starting high potential businesses is in the mid-30s, and there are numerous examples of entrepreneurs starting businesses in their 60s. What is critical is possessing the relevant know-how, experience, and contacts that greatly facilitate recognizing and pursuing an opportunity.

Myth 11-Entrepreneurs are motivated solely by the quest for the almighty dollar.

Reality-Entrepreneurs seeking high potential ventures are more driven by building enterprises and real izing long-term capital gains than by instant gratification through high salaries and perks. A sense of personal achievement and accomplishment, feeling in control of their own destinies, and realizing their vision and dreams are also powerful motivators. Money is viewed as a tool and a way of keeping score.

Myth 12-Entrepreneurs seek power and control over others.

(Continued)

......... ---------------------------------

48

Part I The Opportunity

EXHIBIT 2.15 lConrJudmJ

Reality-Successful entrepreneurs are driven by the quest for responsibility, achievement, and results, rather than for power for its own sake. They thrive on a sense of accomplishment and of outperforming the competition, rather than a personal need for power expressed by dominating and controlling others. By virtue of their accomplishments, they may be powerful and influential, but these are more the by-products of the entrepreneurial process than a driving force behind it.

Myth 13-lf an entrepreneur is talented, success will happen in a year or two.

Reality-An old maxim among venture capitalists says it all: The lemons ripen in two and a half years, but the pearls take seven or eight.

Rarely is a new business established solidly in less than three or four years.

Myth 14-Any entrepreneur with a good idea can raise venture capital.

Reality-Of the ventures of entrepreneurs with good ideas who seek out venture capital, only 1 to 3 out of 100 are funded.

Myth 15-lf an entrepreneur has enough start-up capital, he or she can't miss.

Reality-The opposite is often true; that is, too much money at the outset otten creates euphoria and a spoiled-child syndrome. The accompanying lack of discipline and impulsive spending usually lead to serious problems and failure.

Myth 16-Entrepreneurs are lone wolves and cannot work with others.

Reality-The most successful entrepreneurs are leaders who build great teams and effective relationships working with peers, directors, investors, key customers, key suppliers, and the like.

Myth 17-Unless you attained 600+ on your SATs or GMATs you'll never be a successful entrepreneur.

Reality-EntrepreneuriallQ is a unique combination of creativity, motivation, integrity, leadership, team building, analytical ability and ability to deal with ambiguity and adversity.

likely to be well educated. It also appears that successful entrepreneurs have wide experience in products/markets and across functional areas.44

Studies also have shown that most successful entrepreneurs start companies in their 30s. One study of founders of high-tech companies on Route 128 in Boston from 1982 to 1984 showed that the average age of the founders was 40.

It has been found that entrepreneurs work both more and less than their counterparts in large organizations, that they have high degrees of satisfaction with their jobs, and that they are healthier.45 Another study showed that nearly 21 percent of the founders were over 40 when they embarked on their entrepreneurial career, the majority were in their 30s, and just over one quarter did so by the time they were 25.

WhHl Can Be Learned?

For nearly 30 years, the author has been engaged as an educator, cofounder, investor, advisor and director of new, higher potential ventures. Many of these have been launched by former students and most of the cases in the book are about those founders. One of my most vivid memories is when the great Texas real estate entrepreneur Trammel Crow was inducted into Babson College'S Academy of Distinguished Entrepreneurs. The instant we met he put his arm around me and said: "Perfesser. Do you mean to tell me you think you can actually teach someone to be an on-

tree-pre-newer!" My response was straightforward:

"Mr. Crow, What I think you are really asking me is; am I preposterous enough to believe that in 35 to 40 hours of class time, during a single semester, that I can convert the average student into the economic equivalent of a Picasso or a Beethoven!? Mr. Crow, I think we both know the answer to that question." He laughed and smiled, and said he reckoned he did.

Neu: Venture Creation will immerse you in the dvnamics and realities oflaunching and gro'wing life-style to higher potential ventures. Through the text and multipart cases about real, college- and graduate school-age, and young entrepreneurs, you will face the same situations these aspiring entrepreneurs faced as they sought to turn dream into reality. The cases and text, combined with the accompanying CD-ROM of' supporting materials and exercises, will enable you to grapple with all of the conceptual, practical, financial, and personal issues entrepreneurs encounter. It v v ilI focus your attention on developing answers for the most important of these questions, including:

• What does an entrepreneurial career take?

• What is the difference between a good opportunity and just another idea?

• Is the opportunity I am considering the right opportunity for me, now?

• Why do some firms grow quickly to several million dollars in sales but then stumble, never growing beyond a Single-product firm?

4~ Over 80 studies in this area have been reported in Frontier" ()fEntrepreneu",hip Research (Babson Park ~lA: Babson College) for the vr-ars NSI through Wil7.

40 Stevenson. "Who Are the Harvard Self-Employed?" p. 233. . ,

• What are the critical tasks and hurdles in seizing an opportunity and bUilding the business?

• How much money do I need and when, where, and how can I get it---{)n acceptable terms?

• What financing sources, strategies, and mechanisms can I use from prestart, through the early growth stage, to the harvest of my venture?

• \Vhat are the minimum resources I need to gain control over the opportunity, and how can I do this?

• Is a business plan needed? If so, what kind is needed and how and when should I develop one?

• Who are the constituents for whom I must create or add value to achieve a positive cash flow and to develop harvest options?

• What is mv venture worth and how do I negotiate ~vhat to give up?

• \Vhat are the critical transitions in entrepreneurial management as a firm grows from $1 million to 85 million to $25 minion in sales'?

• What is it that entrepreneurial leaders do differently which enables them to achieve such competitive breakthroughs and advantages, particularly over conventional practices, but also so called 'best practices'?

• \Vhat are the opportunities and implications for 20th century entrepreneurs and the Internet, and how can these be seized and financed?

• What do I need to know and practice in entrepreneurial reasoning and thinking in order to have a competitive edge '?

• What are some of the pitfalls, minefields, and hazards I need to anticipate, prepare for, and respond to?

• What are the contacts and networks I need to access and to develop?

• Do I know what I do and do not know, and do I know what to do about it?

• How can I develop a personal "entrepreneurial game plan" to acquire the experience I need to succeed?

• How critical and sensitive is the timing in each of these areas?

• \Vhy do entrepreneurs who succeed in the long term seek to maintain reputations for integrity and ethical business practices?

There is no question in my mind that we can significantly improve the quality of decisions students make about entrepreneurship, and thereby also improve the fit between what they aspire to do and the requirements of the particular opportunity. In many cases, those choices lead to self-employment or meaningful careers in new and growing firms, and increasingly, in post-Brontosaurus Capitalism, in large firms that "get it." In other cases, students join larger firms whose customer base and/or suppliers are principally the entrepreneurial sector, Still others seek careers in the financial institutions and professional services firms which are at the vortex of the entrepreneurial economy: venture capital, private equity, investment banks, commercial banks, consulting, accounting, and the like.

Regardless of their decisions, my view of entrepreneurship is that it need not be an end in itself. Rather, it is a pathway that leads to innumerable ideas and opportunities, and opens visions of what young people can become. You will learn some skills, and how to use those skills appropriately. You will learn how to tap your own and others' creativity, and to apply your new energy. You will learn the difference between another good idea and a serious opportunity. You will learn the power and potential of the entrepreneurial team. You will learn people skills. YUII will learn that happiness is a positive cash flow. You will learn how entrepreneurs finance and grow their companies, often with ingenious bootstrapping strategies that get big results with minimal resources. You will learn the joy of self-sufficiency and independence. You will learn how entrepreneurial leaders make this happen, and give back to society. You will discover anew what it is about entrepreneurship that gives you sustaining energy and the fuel for your dreams,

One of the best perspectives on this comes from Professor Jerry Gustafson, Coleman-Fannie May Chair, Beloit College, Beloit, Wisconsin, who was probably the first professor at a liberal arts college to create an entrepreneurship course:

Entrepreneurship is important for its own sake. The subject frames an ideal context for students to address perennial questions concerning their identity, objectives, hopes, relation to society, and the tension between thought and action. Entrepreneurship concerns thinking of what we are as persons, ... Furthermore, of it nature, entrepreneurship is about process. One cannot discuss entrepreneurship without encountering the importance of goal-setting, information gathering. persistence, resourcefulness, and resiliency; It is not lost on students that the behaviors and styles of entrepreneurs tend to be SOcially rewarded, and these are precisely the behaviors we wish to see the students exhibit in the classroom.t"

It wax always a shock to my second-year Harvard MBA stlld(:rlls wIH:IJ [ shared the follovving data about ahulilli wllosl: c.;are(:rs were followed for nearly 25 years, H(:ganll,r:ss of tho measure one applies, among tl~(: vr:ry II)J) Ilf 111l! class were graduates who were both hlgJrly ~II('CI'ssrHI and not very successful at all, At the bottom of' lire: cla'is were alu'mni who became outrag(:{)1 dy SI 11:('( :s!ifrll, and others who accomplished little WI,llr Ilre'lr IIVI'S .uul exceptional education, The middle of till: class ;wllieved all points on the continuum of SU<':{'I:,\S, Ilow ('olJld this be? Indeed, I recall as a doctor;,tl SIIII!I"11 ;, research study showing that a combination of (;MAT score and undergraduate CPA to- 7ell II: r .« '( '0111 II r,r! ff)r on Iy 11 percent of the variance In dass 1':"lk ill Ille MBA program,

/\11I:~Zlllg as il may seem, America's brightest fared poorly III 111(' n 'cent Third International Mathematics and Sl'il 'II( 'f' Study comparing high school seniors frolll 20 nul if iux, a<.:cording to the New York Times, In a {'(.HtJPf'l ilion hdw('{>n the world's most precocious sellHH> [II(ISI' laking: physics and advanced math, the AIIl('t'Jl';tllS p(,rjcmned at the bottom, The article nott-d:

A n I 'I" dt'( ':1< II'S of "~()Ilizing over the fairness of S,A.T. SC()I"I',~, llil' dif'fl:rcnccs between male and female math('Illalh'al .~kill.s. and gaps in I.Q. between various races ant] l'llrllil' gJ'lJllps. tlr(, notion of intelligence and how to 1111 ':tSL II< , il [('lllains more political than scientific. and as Hladdl'lIingl\'1'1I1sivc as ever.47

011(' 0111.' 1)( '( 'd consider the critical skills and capacitu« th;rt :Il'I' at the heart of entrepreneurial leadersliip .uu] ;ldlil'\'(·I1lt'nt. vet are not measured bv the IQ (('sh, S.\Ts, (!MATs ~md the like that grad~ and sort yl)J1Il~ :Ipplicants with such imprecision, It is no

Resiliency and capacity to handle adversity Ability to seek, listen, and use feedback Reliahilitv

Dependability

Sense of humor

Clearly, just being very smart won't help much if one doesn't possess numerous other qualities (see Chapters 6,7 and 8: "The Entrepreneurial Mind," "The Entrepreneurial Manager," and "The New Venture Team," respectively, for an elaboration on these other qualities). A fascinatinz article by Chris Argyris, "Teaching Smart People How to Learn," is well worth reading to get some powerful insights into why it is often not the class genius who becomes most successful.t"

ChBpl~r Summary

I, We began to demystify entrepreneurship by examining its classic startup definition, and a broader, holistic way of thinking, reasoning, and acting that is opportunity obsessed and leadership balanced.

2. Entrepreneurship has many metaphors and poses many paradoxes.

3, Getting the odds in your favor is the entrepreneur's perpetual challenge, and the smaller the business the poorer are the odds of survival.

5. The Timmons Model is at the heart of spotting and building the higher potential venture, and understanding its three driving forces: opportunity, the team, and resources; the concept of fit and balance is crucial.

6. Recent research on 906 CEOs of fast-growth ventures nationwide add new validity to the model.

7. There are many myths and realities about entrepreneurship that provide important insights for aspiring entrepreneurs.

8. Entrepreneurship can be learned; it requires an apprenticeship.

9. A word of caution: IQ tests, SATs, GMATs, LSATs and others do not measure some of the most important entrepreneurial abilities and aptitudes.

StUDY OuesUons

1. Can vou define what is meant bv classic entrepreneurship, post- Brontos~urus Capitalism entrepreneurship, the high-potential venture, the threshold concept, cover your equity, bootstrapping of resources, fit and balance? Why and how are these important?

2. How many' additional metaphors and paradoxes about entrepreneurship can you write down?

3. "People don't want to be managed, they want to be led." Explain what this means, and its importance and implications for developing your own style and leadership philosophy.

4. What are the most important determinants of success and failure in new businesses? Who has the best and worst chances for success, and why?

5. What are the most important things you can do to get the odds in your favor?

6. What criteria and characteristics do high-growth entrepreneurs, venture capitalists, and private

51

investors seek in evaluating business opportunities? How can these make a difference?

T. Define and explain The Timmons Model. Apply it and graphically depict, as in the Netscape example, the first five years or so of a new company with which you are familiar.

8. What are the most important skills, values, talents, abilities, and mind-sets one needs to cultivate as an entrepreneur?

MIND STRffCHERS

ltIve VOII D1na!'ft!?

L Who can be an entrepreneur? When?

2. Over 80 percent of entrepreneurs learn the critical skills they need after age 21. What does this mean for you?

3. In vour lifetime the odds are that such leading Il.~s today such as Microsoft, Netscape, Dell Computer, American Airlines, McDonald's, and American Express will be mocked off by upstarts. How will this happen? Why does it present an opportunity? And for whom?

4. What do you need to be doing now, and in the next 12 months to get the odds in your favor?

5. Can you list 100 ideas, and then pick out the best 5 that just might be an opportunity? How can these become opportunities? Who can make them opportunities?

Preparation Oue;llons

1. Evaluate the PC-Build™ business plan and the opportunity.'

2. Should Michael Healey and Robert Lofblad start the business?

3. Would you invest in the business? Join the

venture?

4. What should the founders do?

"We won!" Elation flooded Mike Healey's head with the announcement that he, Bob Lofblad, and their team had won the 1992 MBA Douglass Prize at Babson College for the best proposed business among dozens of business plans submitted to the competition. It was not the $5,000 award plus the engraved watch that were most important. Was this award the confirmation

PC-Build, Inc. *

of nearly a year-long effort to determine whether PCBuild was a serious business opportunity or just another good idea? After all, the panel of judges was made up of experienced and successful entrepreneurs who thought that PC-Build was the best idea of the lot. Mike and Bob wondered if the panel's support was a positive indicator of how the market would assess peBuild's potential.

• Research Associate Christine C Remey prepared this case, under the supervision of Professor Jeffry A Timmons, as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Reprinted with permission from Michael